Why Today's Home Loans Aren't What They Used To Be
Many people are wondering if we're going back to the riskier lending practices and borrowing choices that caused the housing market collapse 15 years ago in today's market. Let's alleviate those worries.
The Mortgage Bankers Association (MBA) publishes an index known as the Mortgage Credit Availability Index (MCAI) several times a year. According to their website:
“The MCAI provides the only standardized quantitative index that is solely focused on mortgage credit. The MCAI is . . . a summary measure which indicates the availability of mortgage credit at a point in time.”
The index, in essence, determines how simple it is to obtain a mortgage. The greater the index, the more readily available mortgage credit becomes. Here's the MCAI graph dating back to 2004, when the data first became accessible:
As the graph shows, the index stood at about 400 in 2004. Mortgage credit became more available as the housing market heated up, and then the index passed 850 in 2006. When the real estate market crashed, so did the MCAI as mortgage money became almost impossible to secure. Thankfully, lending standards have eased somewhat since then, but the index is still low. In April, the index was at 121, which is about one-seventh of what it was in 2006.
Why Did the Stock Market Index Become Uncontrolled During the Housing Bubble?
The primary cause was the abundance of loans with minimal lending standards. To keep up with demand in 2006, several mortgage providers offered borrowing that placed little emphasis on the applicant's eligibility. Lenders were approving loans without always going through a verification procedure to verify if the borrower would be able to pay back the loan.
The FICO® credit score linked with a loan is an example of how relaxed lending standards contributed to the mortgage crisis. What’s a FICO® score? The website myFICO explains:
“A credit score tells lenders about your creditworthiness (how likely you are to pay back a loan based on your credit history). It is calculated using the information in your credit reports. FICO® Scores are the standard for credit scores—used by 90% of top lenders.”
During the housing boom, many mortgages were granted to individuals with a FICO score of less than 620. While there are still some loan options that accept scores as low as 620, today's lending criteria are far more strict. When it comes to assessing risk, lenders are far more cautious than they used to be. According to the New York Federal Reserve's latest Household Debt and Credit Report, the median credit score on all mortgage loans originated in the first quarter of 2022 was 776.
The graph below displays the billions of dollars in mortgage money given out every year to individuals with a credit score of 620 or less.
In 2006, buyers with a score under 620 received $376 billion dollars in loans. In 2021, that number was only $80 billion, and it was only $20 billion in the first quarter of 2022.
In 2006, standards were much less stringent, and there was little effort made to evaluate a borrower's capacity to repay their loan. Today, standards are stricter, and the risk is shared by both lenders and borrowers. These are two very distinct housing markets now; they are not similar to when they were before.